Search-Based Endogenous Illiquidity, Business Cycles and Monetary Policy
Illiquid secondary asset markets have adverse effects on firms' funding conditions and investment decisions. Yet, the micro-foundations of asset liquidity and the impact on aggregate business cycle, and the transmission of (unconventional) monetary policy interventions are scarcely explored. We introduce endogenous asset liquidity into a dynamic macroeconomic model. The endogenously varying asset liquidity is due to search frictions in secondary asset markets. Asset illiquidity creates a role for a liquid asset as a buffer for future funding needs. The liquidity differential between assets gives scope to non-standard monetary policy. The central bank may, for instance, control the supply of liquid assets and change the portfolio composition held by the private sector through asset purchase programs. Our analysis suggests, however, that such policies need to be carefully designed in order not to crowd out private investment.
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